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January 09, 2011

Euro Adoption Will Set Estonia Apart from its Baltic Neighbors, but May Also Create Some Problems for the Republic

Estonia is set to adopt the euro on January 1, 2011, making it the first post-Soviet country to do so. The move should strengthen Estonia’s position in EU institutions and offer a degree of protection from its neighbors’ shaky economies, but it is by no means a panacea, and the changing dynamics of the Euro zone are a reminder that risks remain for the Estonian economy.

Estonians are preparing to say goodbye to the kroon this weekend as the Baltic nation adopts the euro, ahead of its Southern neighbor Latvia and Lithuania. “It’s a mark of quality and stability,” said Andres Kasekamp, director of the Estonian Foreign Policy Institute in Tallinn. “Joining is not only about the economy, but also about identity. We are now finally accepted as a member of all the important European clubs.” Kasekamp added that as recently as two years ago, Estonian entry to the euro zone seemed highly unlikely.

The driving factors behind Estonia’s push to adopt the euro, which began in earnest two years ago, are linked to the financial crisis. From a domestic point of view, economic instability raised the prospect of a speculative run on the kroon. “Joining the euro was the best way to eliminate that risk, which two years ago seemed to be very real,” said Kasekamp. “Then all the talk was about stimulus packages, whereas in Estonia, we were seeing a decline in GDP and the government was just making cuts. When the crisis began, joining the euro was like a light at the end of the tunnel for Estonia.”

Hasty adoption of the euro has also been seen as a way to minimize the taint of proximity to other Baltic countries, particularly Latvia, which was hit extremely hard by the economic downturn, threatening to derail its northern neighbor’s economy as well. “Part of the reason why Estonia decided to join the euro zone was to differentiate itself from the other Baltic States,” said Kasekamp. “Two years ago the media focused on Latvia and its International Monetary Fund (IMF) loan. The speculation then was that it would not be enough, and that Lithuania and Estonia were sure to follow because the Baltic States are seen as one unit.”

The replacement of the kroon has therefore been hailed as an important victory for Estonian politicians, who introduced strict cuts, while the country was suffering one of the worst recessions in the European Union, to meet the euro zone criteria. Adopting the single currency will eliminate currency and balance of payments risk, and has an immediate impact on the country’s international rating. In July, following the final approval from Europe for Estonia to join, Fitch raised its long-term foreign and local currency ratings on Estonia to A, from BBB+ and A- respectively, describing the country’s outlook as “stable.”

The changing dynamics of the euro zone itself have also played a role in Estonia’s entry. As economies within the bloc needed bailing out, the euro became less stable. It is therefore less attractive and there is less talk of economies, such as Estonia, destroying what is no longer a thriving currency. “Two years ago we wouldn’t have been very welcome in the euro zone. In 2006 Lithuania attempted to join the currency, but its inflation rate didn’t fulfill the criteria by a very small margin and it was rejected,” said Kasekamp.

A statement made by President of the European Commission Jose Manuel Barroso in March this year, following a meeting with Estonian Prime Minister Andrus Ansip, reflects how much the situation has changed. Supporting Estonia in its bid to adopt the single currency, Barroso said its determination to do so was an indicator that the euro remained an attractive currency. “The willingness of Estonia to join the euro is a real and concrete demonstration of the importance that the euro has for all of us in the European Union,” he said. “Now we’re a positive success story,” said Kasekamp. “So the tables have turned a little bit.”

Changes that the introduction of the euro entails are also limited by the fact that the kroon has been tied to the euro since 2004. But while instability in the euro zone has made Estonia a more welcome addition to the single currency, some risks remain for the domestic economy.

A major concern in Estonia is the threat of price hikes: a common criticism of the euro when it was introduced in other EU countries is that the change is used to implement price hikes above the rate of inflation, taking advantage of the local people as they adapt to the new currency. And for people in Estonia, the price hikes have already set in. “We have seen price hikes this fall in expectation of joining the euro zone. This is partly because in Estonia and other countries in the region, the cost of goods such as food and petrol has increased,” Kasekamp said, adding that he thinks it is unlikely that there will be any major changes on January 1, as the prices have already gone up. “There is also the fact that the public perception of the price hikes linked to the introduction of the euro and real price rises do not always correspond,” Kasekamp concluded.

Adopting the euro also requires involvement in a stabilization fund set up in the euro zone in May of 2010, called the European Financial Stability Facility (EFSF). Estonia may therefore be called upon to give more financial support to struggling economies in Europe.

While adoption of the euro cements Estonia’s position in Europe, Kasekamp sees potential for a positive impact on Estonian relations with Russia as a consequence of the change. “I think it could lead to a more transparent and honest relationship,” Kasekamp said. “Estonia will feel more firmly implanted in Europe and Russia will also respond to that strengthening of Estonia’s European status.”

Spats between Estonia and Russia have broken out intermittently since the collapse of the Soviet Union. They have been sparked by changes to the status of Russian language in the republic, disagreement over common history and the controversial relocation of the Bronze Soldier, a Soviet war memorial located in Tallinn, by the Estonian government.

1 comment:

New members to the Euro seem confident it will work somehow. So why do nations keep joining it?

Estonia joined in the New Year and there are others set to follow.

As someone who comes from Northern Ireland I've had the choice of Euro or Sterling. Some would prefer Ireland to bring back the Punt. Many aren't sure whether it works for us. They say the first to fall are the first to recover and that the collapse will have a domino effect for others in the Eurozone. Many people in Ireland are against the bailout and feel it should have went to referendum given that the failed government is up for elections soon and the agreement was made in December. The people feel Irish Sovereignty has been lost and this will be a danger for all small states joining the euro.

Estonia seems confident it will work. Here is an interview with their Finance Minister...

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